Tuesday, April 7, 2015

Real Estate prices

Recently I was having a conversation with few of my friends on the topic of real estate prices in India particularly in major cities. In the Indian context, real estate, either refer to a piece of land to construct a house or an apartment in a housing community. The prices of them particularly in the metros are stunningly high. It all points to properties that are astronomically priced, such as a 3-bedroom flat would cost more like a crore or more. If you don’t want to get stuck with others in an apartment complex, people plan to buy a ground (usually 5-6 cents) so that they can construct a house. The land cost alone could exceed lot more than a crore. Of course, if you want to construct a house – that would need an equal amount. Wonder how a salaried family can afford it. Does the price really match the comfort the families expect?

For a nice residence, a typical family would like to have a home with a reasonably good plinth area, unlimited portable water available through the city corporation. It would need 24x7 power supply, with back-up generators in case of any outages. It also needs a perfect sanitation set-up without open ditches. A perfect greenery around with play grounds in the vicinity for kids and to go for a walking during the evenings. Ample wide roads with walking pavements in the entire community. It should be close to public transportation and also have designated parking places for residents, so that cars don’t pile up on the road-sides within the community. Other facilities like schools, colleges should be in reachable distance and approachable. More than that, an atmosphere of calmness without dusts or pollution and a community with bullet-proof security. An unsecure neighborhood are nightmares. Finally a more ambient place to raise a family and kids. Unfortunately these highly-priced real-estates have absolutely none of them.

Except very few real-estates that are often in completely out-of-reach prices – most have some or all of the below problems.

Bare-minimum water supply

Erratic power supply

Open ditches and poor sanitation

No designated parking lots for cars except on roads that interfere with traffic

Narrow lanes within community

Dusty roads without proper pavements

Noisy crowd with no security

But the problem is – THEY still cost a lot.

In economic terms, these real-estate entities are called assets. The pricing on them are called asset-pricing. In India, for the past 7-10 years, we have seen many fold increase in asset-pricing. The prices of items that we shop daily like groceries, fruits, vegetables, fuel are noted in the CPI (Consumer Price Index). It grabs attention when they go up. Hence, there is always a check. But asset-price inflation is never tracked in the big picture. The prices of them keep going north without logic. Easy availability of bank credit to the nucleus families has only exaggerated this boom. A lot of buyers chased very few properties. With the interest rate now being held-up high for the past 2-3 years, the credit boom has come down. The correction to the market is underway now. This explains the rise in NPA in banks, and the gross under-performance of many real estate firms. Most real estate firms have enormous debt and are deeply in distress. The sorry state of Sahara India and the plight of its owner is a classic example of how bad things are.

I think, the prices of assets have really hit the roof. The value you pay, is not worth it in current financial terms. Except for a bad government policy like - future devaluation of the Indian rupee could only make these asset purchases a right decision.

Real-estate price distortions can be identified very easily.

The first indication – is the rent, the properties can fetch. In the past decade, we ourselves have experienced that even though the prices of assets have gone up many folds – rents have not kept pace with them. These one-crore properties don’t even fetch Rs.25,000/- on rents. In monetary terms – it would take 34 years to recoup the price of the property with this amount (without interest). There is an argument that the property can be flipped for more for a capital gain on a later date. The argument does not hold well, because the buyer in that transaction – has to deal with the SAME Rs. 25,000/- rent. What would be his incentive to pay more? It would take more years to get back his investment. On top of that it costs to maintain the property. Economically smart people – always rent their houses. This makes sure they have easy payments to make as rents without any long-term commitments. On the sign of first trouble like – insufficient portable water, unsafe neighborhood, they would vacate it to find a better home somewhere else.

The second indication – Banks chip in for inflated prices. The developers lure in the financial institutions to get the ordinary guy “get in”. Without the bank-loan, he would not be a player at all. He just would not be able to afford it. Interestingly, it is a habit among us, to price the property in the selling price. Most of the time, people borrow money from the banks and pay EMIs on them. What is often overlooked is the price on the property is not the selling price, but instead it is the initial payment plus the cumulative amount paid to the bank as EMIs. With high interest rates now – a one crore property would double when paid over a ten-year loan term. So the price of the property is two crores and not one crore, as often described in conversations.

The third indication - the source of funds is always another real estate deal. The money earned to buy the high-priced real estate is obtained by selling another piece of real estate. It is like, selling a rural home or a rural agriculture land, and investing the proceeds in a apartment property in the city. Ideally the money to buy a commodity should be earned through "some other means". The means should be derived from a productive labor of the individual in some other profession - like profit from a business, agriculture income, etc. A debt-based purchase with the anticipated future income is not a smart investment.

The fourth indication - Rapid appreciation of property is predominant goal of the purchase. People consider it investment. The simple rule in home-buying is - If you buy a house and go live in it, then it is NOT an investment. It is consumption.

The fifth indication - the price of the property keeps increasing just “by word of mouth”. The facilities would have all sorts of performance problems, but the price keeps going up artificially. The price to sustain what is “already present” would always increase. The price can improve only as quality of the asset increases, but seldom is the case.

With lagging infrastructure worries in our country – people are being fooled into high-priced assets in the name of modernity. People expect a lot and go for it and then get stuck. Luck plays a role for some, so that they end up with better homes. Unfortunately the whole country can’t be lucky. A viable and performing infrastructure set-up would make the cost of all real-estate prices to go down. This is what would grow the economy. In a real growing economy – prices come down and hence affordability rises creating enhanced quality of living. As of now, there is no real growth in the way real estate is being practiced in India. India is not a land-deficient country. It is a vast country and we need a make-over in the way people live in their homes. Homes should have "all necessities" by default - their location shouldn't matter - if they are in the middle of the city or in the outskirts.

All we need is the work-force of our country work hard (and diligently) to resolve “our” neighborhood problems. Majority of our human resources should be working for professional companies that “solve” these infrastructure issues for us. Instead what we see is a majority of our skilled people who are highly smart, referred to as the cream of the society, working for multinational companies that makes life better for people living in some far-away countries. We need to export stuffs too – but the primary motive should be for development within.

About Me

The author of this blog is an Indian Citizen and works on computers for a living. Areas of interests includes Indian Politics, International Affairs and Business economics and all issues related to common man.